Top U.K. Banks Face $39 Billion Shortfall Under BOE Failure Rule

The U.K.’s biggest banks will need to issue 26 billion pounds ($39 billion) of new loss-absorbing securities to comply with rules intended to ensure they can be wound down without resorting to a taxpayer-funded bailout or halting services crucial to the economy.

The Bank of England estimated that in all, firms subject to bail-in as a part of resolution will need 221 billion pounds of debt to meet new bank-specific requirements for liabilities that can bear losses. The net figure, which takes account of banks’ normal rate of issuance, corresponds to about 0.4 percent of the total assets of the lenders concerned.

Under European Union law, the Bank of England must set the requirements for own funds and eligible liabilities, known as MREL, starting on Jan. 1 for all U.K. banks, building societies and investment firms supervised by the PRA. The goal is to prevent the costly public rescues of banks seen during the financial crisis. The requirement can be met with regulatory capital and long-term unsecured debt. 

“The implementation of MREL is a crucial step forward in ensuring that any bank, large or small, carries sufficient resources to be resolved in an orderly way, without recourse to public subsidy and without disruption to the wider financial system,” said Mark Carney, governor of the BOE.

The Bank of England published two consultation papers on Friday as it gears up to set MREL in line with EU law and rules proposed by the European Banking Authority.

‘Core Element’

Carney said earlier this week that the “core element” of the rules is “the knowledge in advance” that instruments used to satisfy MREL are in line for losses when a bank gets into trouble.

This knowledge “provides much more discipline to the system,” Carney said. “The holders of that debt should provide discipline on top of the discipline that should have been provided by equity holders, but is not because the interests aren’t perfectly aligned.”

MREL consists of two parts: an amount intended to cover losses before and during resolution; and a second amount for recapitalization, enabling the bank, or parts of it, to hold on to its license and maintain market confidence.

The EU’s rules complement global standards approved by the Group of 20 leaders last month for the world’s biggest lenders, known as total loss-absorbing capacity, or TLAC. Carney said “TLAC is a subset of MREL,” and in the U.K. the implementation of the two sets of rules would go hand in hand.

‘Proportionate Approach’

The Bank of England will take a “proportionate approach” in setting MREL for U.K. banks, taking into account their size, the critical economic functions they perform and the complexity of transferring these activities to other entities during a wind-down.

The BOE said that lenders shouldn’t be able to count common equity Tier 1 capital, a measure of financial strength, both toward European Union resolution rules and the risk-weighted capital and leverage buffers set by regulators. “Depending on their business model and liability structure, firms may need to increase financial resources to avoid double-counting,” it said.

The inability to count common equity Tier 1 capital both toward MREL and regulatory buffers means the maximum impact depends on the size of the buffers, the BOE said. The range of impact will be 2.5 percent to 4.5 percent of risk-weighted assets.

Baseline Approach

“Firms can respond to this impact in a number of ways,” the BOE said: “by issuing more eligible liabilities, converting ineligible liabilities into eligible ones or issuing non-regulatory CET1 capital or CET1 capital.” The least costly way would be to issue MREL-eligible liabilities, it said.

In determining the first part of MREL, resolution authorities should ensure as a baseline that losses equal to the capital requirements set by a bank’s supervisor, including buffers, can be absorbed, according to rules proposed by the European Banking Authority earlier this year.

This loss-absorption amount can be set higher or lower by the national resolution authority, the EBA said. One reason for reducing the amount is if part of a bank’s combined buffer requirement is deemed irrelevant to resolution.

The recapitalization component can be set at zero for smaller banks that can be liquidated in normal insolvency proceedings, the EBA said. For other lenders, this amount should be at least sufficient to satisfy the capital requirements necessary for authorization and the implementation of their resolution plan.

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